Monday, February 18, 2013

Yes, the euro crisis and the European crisis are still with us

P.W. at the Economist's Free Exchange blog reports on the recent news about the state of the European economy, Valentine's Day Massacre 02/14/2013:

The hole into which the euro zone has slipped is even deeper than had been expected.

Across the 17-strong group of countries sharing a single currency output dropped by 0.6% on its level in the third quarter, leaving GDP 0.9% lower than a year before. Over the whole year of 2012 euro-area GDP fell by 0.5% compared with 2011. The setback affected the creditor countries in the core of the euro area as well as the debtor countries on the periphery. In Germany GDP declined by 0.6%; in France by 0.3%; in the Netherlands by 0.2%; and in Finland by 0.5%.

The reverse was much more severe among the countries on the euro-zone periphery. Italy experienced a sharp contraction in output, which was 0.9% down on the previous quarter, leaving it 2.7% lower than a year earlier. This will do nothing to help Mario Monti’s hopes in a crucial election later this month. Among the five countries that have required (or, in the case of Cyprus, are negotiating) official bail-outs, the reverse was particularly severe in Portugal, where output fell by 1.8% compared with the previous quarter, leaving it 3.8% lower than a year earlier. (In Greece, where official seasonally adjusted figures are not available making a quarterly growth figure meaningless, output was 6% down on a year earlier.)

An interesting twist, that amounts to setting up a propaganda opportunity more than any real progress, Ireland is paying off some of its debt via a convoluted form of "monetary financing."

Wolfgang Münchau in Ireland shows the way with its debt dealFinancial Times 02/10/2013 gives a description of the convolutions involved, all of which mount to a rescheduling of the Irish debt: "Without rescheduling, the Irish economy would have fallen into a debt trap with an uncertain outcome. Ireland's debt sustainability is secure - for now. And as Ireland's finance minister Michael Noonan helpfully reminded us, with such a long-term bond, inflation will take care of most of the debt."

And he argues that the complex nature of the arrangement is useful for the EU authorities in Berlin and Frankfurt. "As always, convolution has a purpose. It renders legal what would otherwise not be, and it allows for obfuscation."

He is willing to be a bit optimistic about this development:

In an ideal world, there would be a political deal on bank resolution and deposit insurance, a eurozone bond, and on economic adjustment. Back on earth, the ECB is all we have.

When Mario Draghi, president of the ECB, gave his now famous "whatever it takes" lender-of-last-resort pledge last year, I wrote that this would slow down the political process. Last week, the ECB went even further by acquiescing to a hidden form of monetary financing [in the Irish case]. The ECB will probably not compromise over inflation soon. But then again, I cannot really see the ECB resisting the ongoing changes that are currently taking place in global central banking either.

To begin with, to be 'out of the woods' ought to mean a capacity to finance one’s state without relying on direct or indirect state financing by any of the troika’s branches. It means that Dublin, Lisbon, Rome, Madrid can run their own fiscal policy without the direct supervision of the troika and without reliance on the troika’s willful actions to secure the sustainability of that fiscal policy. It will be my claim, below, that none of the 'fallen' Eurozone states (Ireland, Portugal, Spain and even Italy) are nearer this 'happy ending' today than they were in July 2012.

As he explains, the ECB's do-whatever-it-takes announcement last year, which has so impressed those eager to find magical powers in the arcane workings of wise central bankers, was a move that successfully aimed at undercutting aggressive speculators:

The bond market calm that broke out recently is entirely due to Mr Draghi’s OMT (outright monetary transactions) program announcement last September. What was the purpose of the OMT? Put simply, to address the utter incapacity of the EFSF-ESM bailout fund to bail out Italy and Spain. After Germany’s rejection of any suggestion that the EFSF-ESM should be allowed to borrow more money, or that the ECB’s balance sheet should be used to lever up the EFSF-ESM’s funds, it became abundantly clear that, as Spain and Italy were being brutalised by money markets shorting their bonds, there was no way that their combined 3 trillion euro debt could be stabilised. It was at that point that Mr Draghi had to step in, somehow, to plug that gap and, effectively, signal to bond traders that further shorting of Italian and Spanish debt would lose them money. ...

The ECB’s recent announcement of its agreement on the conversion of Ireland’s promissory notes into long term bonds concludes this deal [which Münchau discusses]: The Irish taxpayer will continue to be burdened with huge, unsustainable long term debts taken out by bankers who are now defunct and who should never been backed by the Irish state. Austerity-driven self-perpetuating recession, and the resulting stalled recovery, will remain the order of the day. The fact, however, that Ireland’s sovereign debt is unsustainable and that its largely self-inflicted austerity has failed will, from now on, be hidden behind an OMT-created façade. The troika will continue to be the effective government of Ireland and the Irish state will continue, just as it has been since September 2010, to require the direct interventions of the ECB in order to maintain its ‘market access’. All that has changed is the rhetoric, which now rewards Dublin with the Pyrrhic victory of claiming, with a little more self-confidence, that "it is not Greece". [my emphasis]

But it was a solution to that round of speculation, not to the problems of the eurozone.

The move was also a recognition that Italy and Spain are under the direction of the EU Troika (ECB, IMF, EU Commission):

While OMT financing was also conditional on Italy and Spain to be placed under troika supervision, under a full troika program, bond traders refrained from testing Mr Draghi’s commitment for two reasons: First, because of the Beauty Contest effect (i.e. each bond trader believed that average opinion among bond traders was that, for the time being, it does not pay to mess with Mario) and, secondly, because Mr Draghi and the EU hinted at a willingness to consider Madrid’s and Rome’s existing austerity policies as a de facto troika program, at least in the short run.

Thus, Italian and Spanish bond yields collapsed despite a colossal deterioration in the real economy’s fundamentals for both these countries. And as their bond yields fell, a rally of all bonds began throughout the Eurozone aided and abetted massively by Mrs Merkel’s decision to proclaim that Grexit [i.e., Greek exit from the eurozone] was off the table, until further notice at least.

What benefits does German Chancellor Angela "Frau Fritz" Merkel get out of this? Varoufakis gives these three:

How to avoid telling the German electorate [in this parliamentary election year] that Spain, Ireland, Portugal and, eventually, Italy will need gargantuan fiscal assistance that the EFSF-ESM was incapable of providing.

How to break the news to them, months before the German federal election, that Ireland, Spain and Portugal, in addition to Greece, will require fiscal financing ad infinitum.

How to tell the Irish people that their suffering had no tangible effect.

His summation of the Irish deal: "There has been no progress whatsoever! Indeed, the Eurozone crisis is getting worse the calmer the bond markets seem and the more confident the commentariat is becoming that Ireland and Portugal are out of the woods."

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